Director’s law?

I won’t explain what it is, for that read here. I thought of that reading Economics of Contempt on community banks and credit unions’ opposition to the Durbin amendment (I have no idea what’s in said amendment). EoC quotes Barney Frank (in a different context) saying “The lobbying power doesn’t come from the big banks. The community banks beat the big banks.” I recall earlier hearing from Charles Calomiris that deposit insurance was pushed through over F.D.R’s objections (memories of such insurance at the state level was still fresh in his mind) by the small-bank lobby in the southeast, although it was initially limited to much smaller amounts. Scott Sumner said here that the “too-big-to-fail” investment banks have been blamed when small ones are causing more losses to the taxpayers. I’ve been persuaded by the free-bankers referencing Canada that large diversified banks unhampered by American-style branch restrictions are more stable in a crash, but it is in tension with my implicit model for most businesses. Larger numbers of firms generally results in more competition and benefit to the consumer (though perhaps the condition of free entry is more important than actual numbers), and under Mancur Olson’s theory of collective action a small number of actors can more easily lobby (or even just maintain a “gentleman’s agreement”) to rent-seek. Perhaps my folk model doesn’t take into account public opinion, which may go stupid for “small business”. Those of Randian bent might think in terms of a conspiracy of the mediocre. Even folks not of such bent like Albert O. Hirschmann can make such noises at times.

Robin Hanson said that big businesses are preferable because they are easier to regulate here. Your mileage may vary on that one. Like Brian Doherty, I’d be particularly interested in hearing the left-libertarian class-warfare angle.

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11 Responses to “Director’s law?”

Whatever may have been the case in the 1930s, community banks aren’t causing “more losses to the taxpayer” now. It was large banks that took most TARP monies, although these have largely been paid back. The largest amount of federal “bail-out” money that remains outstanding is that sunk into the GSEs, Fannie Mae and Freddie Mac. This appears to have little probability of being repaid.

The FDIC is funded by premiums paid by insured banks, not by general tax revenues. Community banks pay a disproportionately high percentage of total FDIC premiums if this be considered in terms of their overall size. The reason for this has to do with the basis on which the premiums are calculated. There have been a good number of small bank failures, but these have been handled in the regular course of business by the FDIC.

Going back to depression-era banking losses, it’s noteworthy that many small banks failed at this time because of bad investments, not bad loans to their local customers. Ron Chernow, in his book “The House of Morgan,” presents some interesting information on this. During WWI, the Treasury required all foreign bond issues in through U.S. investment banks to be submitted to it for approval. After the peace, it retained this power, and used it to steer credits to Latin American countries which historically had terrible credit records. Treasury’s “stamp of approval” on the securities of these countries was unduly regarded by small banks and individual investors as an implicit endorsement of their quality. Of course, it all ended in tears. We took a loss at my bank in 1930 on Republic of Panama bonds. I knew this long before I read Chernow’s book, and after I did, the pattern made sense.

There is a parallel to this today in the implicit endorsement of the GSEs’ securities by the U.S. government. The difference is that the agencies’ bonds have been propped up by the Fed, which the Treasury-approved foreign credits were not in the 1930s. The GSEs’ preferred stocks, however, have not been backed in the same manner, and banks that invested in them (e.g., OneUnited, of which Rep. Maxine Waters’s husband was a director) have suffered as a consequence.

As you are perhaps aware, when you use a credit card, the merchant gets perhaps 97 to 98 cents of every dollar you spend. The rest is a fee that is split between the credit card issuer and the clearing bank. Your credit card charge amounts to a short-term draft that is discounted by an amount that effectively serves as interest on the money for the period that elapses between the date of the charge and the due date of your next monthly statement. You don’t see this as an interest charge, but interest is actually being paid on your indebtedness for that first month or so – just not directly by you. The draft is being discounted by 200 to 300 basis points, which (given the average length of time between charge and statement, plus the grace period) probably amounts to a 20-25% per annum rate of interest on your new balance.

Debit cards clear through the same system that credit cards do, but instead of functioning as a short-term draft, function effectively as a check would do. Yet there is also a percentage discount on the use of a debit card, which although not as great as with a credit card, can still amount to a considerable sum when the transaction is a large one. It is typically a little more than 1%.

The Durbin amendment would limit this interchange fee to between 7 and 12 cents per transaction. If you consider that on a $100 purchase, the interchange fee under the status quo ante might have amounted to (say) $1.00, that’s quite a considerable decline.

Institutions with footings less than $10 billion (which includes just about all community banks and credit unions) are exempted from the formal purview of the Durbin amendment. However, this is hardly of practical benefit to them, since under the amendment, retailers who accept debit cards have a choice of multiple networks through which to clear debit card charges. This obviously favors the networks offered by the large institutions that are subject to the price controls, as opposed to those offered by smaller ones legally able to charge higher interchange fees. In effect, the smaller institutions will be forced by the competition from price-controlled large institutions either to meet their lower rates, or to abandon the market.

No one in the financial industry likes the Durbin amendment. Large debit-card operations like Bank of America’s or Wells Fargo’s will face huge losses of revenue, and so will smaller competitors like community banks and credit unions, for the mentioned reasons. This comes at a time when interest-rate margins (i.e., the difference between a bank’s return on loans and its cost of deposits) are contracting.

The fact is that somehow the costs of a bank’s operations have to be paid, and the loss of interchange fees will mean that some services customers have taken for granted as free (e.g., consumer and small-business checking accounts) won’t be any more. The fee income will be made up somewhere else. Naturally, banks are fearful of upsetting customers by introducing such fees as a charge per check written, etc.

Re: the large Canadian banks, etc., it should be noted that Canada has not experienced anything like the U.S. real-estate bubble and its subsequent burst.. The reason for this is not the size and diversification of the Canadian banks, but the absence in Canada of an active government policy of promoting home-ownership, comparable to that which existed here through Fannie Mae, Freddie Mac, and the large secondary mortgage market. These institutions, with their loose underwriting and inadequate collateral requirements, dominated the market; private-sector competitors either had to meet or beat their terms, or walk away from the business.

As for “Director’s law,” it seems to me not particularly relevant to the discussion of these banking issues – though the “bar bell coalition made up of the politically savvy and the lowest classes” described in the linked page about “The End of Director’s Law?” seems to me awfully like Moldbug’s brahmin-dalit-helot coalition against the optimates and vaisyas.

Interesting Connections, I cannot with any confidence say whether Director’s Law is now or has ever been in effect. I do think that just as in a democracy no candidate wants to speak ill of “the people” (even when the truth demands it), in our country the middle class is supposed to be praised for upholding AMERICA despite being so put upon. So I find the portrayal of the middle class as rent-seekers against the top and bottom to be interestingly novel. Hopefully Anonymous sometimes makes remarks in that direction, but it’s framed more in terms of America vs the rest of the world.

The disproportion in the amount of FDIC premium paid by community banks as opposed to the large nationwide operations like Wells Fargo, JP Morgan Chase, etc., has to do with the latter’s deposit mix (more large deposits over the FDIC maximum coverage, more foreign deposits) and the pass that they have generally got on the capital adequacy and asset quality portions of their CAMELS ratings because they are “too big to fail.” If the government is going to bail out big banks, essentially guaranteeing that all their depositors shall be made whole regardless of the size of their accounts, to wink at bad quality assets and insufficient capital ratios simply on the basis of their size and political influence, the present apportionment of their premiums does not adequately cover the risk they pose to the system.

Another real problem with the FDIC is that it has a mandate to enforce compliance with social-engineering regulations such as the CRA and HMDA, with equal force to their safety-and-soundness criteria. These regulations boil down to a political allocation of credit to the un-creditworthy. The effect of this is akin to a fire insurance company encouraging its customers to keep oily rags under the kitchen sink and to smoke in bed.

Of course paying on the amount covered makes sense – if it’s really the amount covered. The bail-out of big banks like Citi and the effective coverage of all their deposits regardless of size shows that FDIC maximum limits are meaningless.

Also, why were those big banks allowed to operate with deficient capital and poor asset quality without their CAMELS ratings being downgraded?

2. Even if it were, they aren’t all that close to being rationally self-interested anyway

3. Even if they were, they’re nowhere near being able to resist elite propaganda, anyway. Sure, there is an immense space of propaganda that they can resist quite aptly, but the set of what they can’t resist is still quite roomy. Roomy enough that almost any goal can be pursued pretty efficiently.

Just look at the most important phenomenon in the West in the postwar period, which is mass immigration – doesn’t instantiate Director’s Law.

I don’t mean to imply that there’s necessarily anything like a coherent elite plan, though.